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European Banks Tally Losses Linked to Fraud

PARIS — In early 2003, as word of Bernard L. Madoff’s apparent Midas touch spread among affluent Europeans and money managers, a team from Société Générale’s investment bank here was sent to New York to perform some routine due diligence.

What it found that March was hardly routine: Mr. Madoff’s numbers simply did not add up. Société Générale immediately put Bernard L. Madoff Investment Securities on its internal blacklist, forbidding its investment bank from doing business with him, and also strongly discouraging wealthy clients at its private bank from his investments.

The red flags at Mr. Madoff’s firm were so obvious, said one banker with direct knowledge of the case, that Société Générale “didn’t hesitate. It was very strange.”

While the bank kept the discovery to itself, as is common in the secretive world of wealth management, the information saved Société Générale more than embarrassment: its total exposure to Mr. Madoff’s apparent Ponzi scheme is less than 10 million euros, or $13.8 million.

That’s a fraction of the losses at competitors like BNP Paribas or HSBC, which made loans to institutions that invested with Mr. Madoff, who prosecutors say paid investors by raising money from others rather than generating real profits.

But the size of the scheme calls into question why other big reputable banks in Spain, Britain and especially Switzerland, the world’s premier wealth haven, failed to spot the risks of putting billions of euros, pounds and Swiss francs into Mr. Madoff’s hands.

Indeed, Switzerland has long prided itself as the home of Europe’s most discreet and cautious bankers. But now, “L’affaire Madoff” is front-page news in Geneva and the talk of cantons like Lucerne and Zug, which specialize in managing other people’s money.

Elsewhere in Europe, the losses do not just stem from individual investors who were burned. Large banks like HSBC and the Royal Bank of Scotland lent more than $1.5 billion to money management firms, which leveraged larger returns on their investments with Mr. Madoff. In return, these big banks received collateral in the form of assets in Mr. Madoff’s firm, which are most likely worthless now.

The latest European victim to reveal losses is Bank Medici of Austria. Two funds at the bank, based in Vienna and 75 percent owned by its chairwoman, Sonja Kohn, invested $2.1 billion entirely in Mr. Madoff’s firm, the bank said on Tuesday. So far, financial institutions on the Continent and in the United Kingdom have announced $10 billion worth of exposure.

Europe appeared to represent a potentially lucrative territory for Mr. Madoff, whose alleged scheme would have required a regular flow of new funds to continue. Although Société Générale’s ban on investments in his fund dates to 2003, so renowned was Mr. Madoff that some of the bank’s clients were demanding access as recently as early this year.

Société Générale’s audit at the time was conducted by three people who visited Mr. Madoff’s headquarters in the red-granite skyscraper on Third Avenue in Manhattan. They were part of a larger 25-person group examining a potential acquisition of Zurich Capital Markets, which had lent money to investors in Mr. Madoff firm, among others.

Mr. Madoff’s employees told the team that his strategy consisted of balancing holdings in large Standard & Poor’s stocks with options to buy and sell shares, known as puts and calls, according to the banker, who was not authorized to speak publicly about the matter.

Ideally, this approach produces low volatility and minimizes risk. But when Société Générale back-tested the strategy, it could not match the results that Mr. Madoff claimed to have produced.

“It’s a strategy that can lose sometimes, but the monthly returns were almost all positive,” the banker said. “Something wasn’t right.” Société Générale was also troubled by the fact that Peter Madoff, Mr. Madoff’s brother, was the chief compliance officer.

Ultimately, Zurich Capital Markets, then a unit of Zurich Financial Services, was sold to BNP Paribas, the cross-town rival of Société Générale.

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BNP Paribas has nearly $500 million in exposure to Mr. Madoff, a major contributor to the $1.4 billion loss the Paris giant’s corporate and investment banking unit announced on Tuesday for the first 11 months of 2008.

Like HSBC, BNP Paribas had losses on money it lent to hedge fund firms, which in turn invested the cash with Mr. Madoff. BNP Paribas’s collateral, quite possibly worthless, included a stake in the Madoff fund.

Mr. Madoff’s firm had been especially appealing to Continental investors because it appeared to offer the kind of steady, predictable returns with a minimum of volatility that conservative European institutions — and especially private family money managers — typically seek.

Photo

BNP Paribas has nearly $500 million in exposure to the Madoff firm. Its banking unit posted a $1.4 billion loss on Tuesday.Credit
Antoine Antoniol/Bloomberg News

Société Générale, itself the victim of an apparent scam early this year when unauthorized bets by a trader, Jérôme Kerviel, caused a $7 billion loss, was not the only financial firm to think Mr. Madoff’s unfailing record was too good to be true, said Drago Indjic, a project manager at the Hedge Fund Center of the London Business School.

“Madoff did not pass due diligence for many European hedge fund companies,” Mr. Indjic said. “Experienced people know there are many ways to provide the kind of return stream offered by Madoff, almost like a bank account, and one of them is a Ponzi scheme.”

Smaller American investment advisory firms like Acorn Partners and Aksia also spotted problems with Mr. Madoff’s strategy early on, but Société Générale is the first major investment player known to have steered clients away him.

Mr. Indjic said the scheme revealed not only faulty due diligence, but also a basic failure to diversify. “If you had half a percentage point of total assets under management with one firm, that is more typical,” he said. “But some had much, much more than that with Madoff, so their due diligence failure was compounded by poor portfolio management.”

One of the hardest-hit European victims, Optimal Investment Services of Geneva, was unusually concentrated in Mr. Madoff’s firm. A unit of Santander of Spain, Optimal had $3.1 billion invested with Mr. Madoff through its Optimal Strategic U.S. Equity Fund, out of a total of $10.5 billion under management.

Optimal and a spokesman for Santander declined to comment.

While the losses at Santander and Optimal are huge, other famously conservative European financial names have also been tarnished by their link to Mr. Madoff.

Union Bancaire Privée, based in Geneva, had an approximate $1 billion exposure to the firm, or about 1 percent of its $125 billion in assets under management.The losses are an embarrassment for the firm, which has long promoted itself as an expert in diversification, risk management and finding safe products for its investors.

But they are also awkward for the Swiss banking establishment, which was rocked this year when top executives at UBS, one of its biggest banks, resigned after revealing billions of losses on American subprime mortgage debt.

Swiss officials said they were shocked by the suspected scheme, but directed the blame back at the United States, especially American regulators, like the Securities and Exchange Commission, and accounting firms.

“Like the rest of the world, we are scratching our heads, wondering how on earth the S.E.C. and top auditing companies could have had the wool pulled over their eyes for so many years,” James Nason, a spokesman for the Swiss Bankers Association, said.

A version of this article appears in print on , on Page B1 of the New York edition with the headline: European Banks Tally Losses Linked to Fraud. Order Reprints|Today's Paper|Subscribe